Dreyfus Neenan at Morningstar challenges the conventional regarding the superiority of index funds. In his recent article regarding how stock picking can outperform index funds, he points to several weakness in index funds that can be overcome with selective stock picking focused on value. He does note that index funds have beat 75 percent of all large-blend mutual funds. Those sound like tough odds to beat, but I agree with Neenan’s main points:
- Index funds at times they can be horrendously risky.
- The entire value of the market can become overvalued.
- The stocks in the index are not selected based on merit, but often for industry diversity to reflect the general economy.
- Capitalization-weighted indexes will result in the index to overweight overvalued stocks
Morningstar has developed a ten stock portfolio of the current best value stocks in their database to track whether stock picking can indeed outperform an index fund over the next ten year. This will definitely be worth following.